'Like a two-by-four to the forehead': Fed not subtle about next move
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A few years ago, the Federal Reserve decided to have the chair of the Federal Open Markets Committee (FOMC) hold a press conference after every other meeting. These meetings also coincide with the release of quarterly projections for key economic variables, as well as the Fed’s policy rate. The four so-called “press conference meetings” each year have become big events for the financial markets.

Conversely, the non-press-conference meetings have evolved into sleepy affairs. The FOMC has fallen into a pattern of making all key policy changes at press conference meetings and barely even bothers to alter the post-meeting statements at the other four gatherings. This week’s meeting was one of these off-cycle statements, and the Fed certainly maintained its pattern, making no policy announcements and only a few minimal changes to the wording of the FOMC statement.

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Market participants were looking to the July FOMC statement for any subtle hints on two important topics: First, given a series of softer inflation readings in recent months, would the FOMC change its view that the bulk of the cooling in inflation in recent months was “transitory,” as Janet Yellen put it recently? The Fed did make a very small tweak to the statement to acknowledge that core inflation has moderated, but, more importantly, there was no change to the inflation forecast.

 

The committee remains steadfast that inflation will accelerate to its 2-percent target “over the medium term.” This would suggest that, as of today, the FOMC still believes that its projections of “gradual” rate hikes over the next few years (roughly three hikes per year in 2017, 2018 and 2019) remains an appropriate outlook, at least until the September FOMC meeting, when a new round of forecasts will be released.

The other key topic in this week’s FOMC statement was the prospect of balance sheet reductions. After several rounds of quantitative easing (QE) in the years after the financial crisis, the Fed has been standing pat for a long time with a bloated $4.5-trillion balance sheet. Over the course of 2017, Fed officials have been trying to convince market participants that it would begin to finally unwind some of those holdings soon.

In June, the FOMC laid out exactly how that process would play out, leaving the only outstanding question to be a start date for securities redemptions. The overarching goal for the Fed in this signaling process has been to insure that when it finally begins to reduce its holdings, the market reaction is muted — because asset prices already reflected an expectation of the Fed’s moves.

In that regard, balance sheet reduction from the Fed will be one of the most well-advertised moves in history. It is rare to see a more careful and extensive forward guidance campaign, as officials have been talking about this extensively for close to all of 2017. Imagine driving along the interstate and seeing 10 signs, each about a 10th of a mile apart, warning you about the coming exit from the highway.

This week’s statement included what I expect to be the last of that series of warning signs. The July FOMC communique noted that balance sheet reduction will begin “relatively soon,” echoing language used by Chair Yellen a few weeks ago in congressional testimony, as well as declaring that the Fed was only maintaining its current policy “for the time being.”

While these may seem like much more subtle warnings than the road sign example, in the realm of "Fedspeak," it could be argued that this is closer to an oversized sign with flashing lights, or perhaps, to use another image, a proverbial two-by-four to the forehead.

The FOMC is telling us that it currently plans to finally announce the beginning of balance sheet reduction at its next meeting in September. By the way, their efforts have been fruitful, as financial markets have come to expect exactly that, so that Fed officials can be fairly comfortable that a September announcement should come and go without creating much upheaval in asset prices.

Stephen Stanley is the chief economist for Amherst Pierpont Securities, a broker-dealer providing institutional and middle-market clients with access to fixed-income products.


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